The new requirements pushed on dairymen are abnormal business practices for dairies but standard for all other industries. Dairy operators need to implement these tools into permanent practice. They are invaluable.

We all know times have changed, and gone are the days when we were able to call our banker, ask for more money and have the money in the account by the time we hung up the phone.

The approach to doing business today is evolving and involving more financial players actively at the table. Multiple years of low milk prices, high feed costs, or both simultaneously have drained generations of equity from our balance sheet and called for critical changes in business practices.

The past few years have been a wake-up call to many dairies who weren’t intimately engaged in the financial side of their operation. Accounting was done for compliance work only and if financial statements were prepared, they weren’t reviewed or discussed but tucked nicely into a filing cabinet. No other multi-million dollar business operation in other industries ever had as much financial latitude as dairies previously had.

Due to the large reduction in equity and borrowing base (herd and feed values less the amount owed for the herd and feed) with the bank, dairies have been and still are facing uncertain times. Dairy owners are being required to do more financial work than they’ve ever done before. For most operations, credit is the biggest hurdle right now.

This increases the level of stress and questions in the daily operations. This is not only where your accountant comes into play as an active advisor, but also your banker and attorney in assisting with negotiating loan terms, developing and agreeing to operation budgets, and creating a plan to return to compliance with loan covenants when needed.

Most businesses have operating budgets that are developed by the business and reviewed on a frequent basis throughout the year. Clients we work with in other industries review their profit and loss statement with us each month. The actual results are compared to budgeted results. Variances are analyzed and changes are made mid-stream if appropriate for the business to meet its desired result – profitability.

In the past, many dairy operator/owners would approve, half-heartedly, budgets prepared by the banks and only look at it as they were signing the annual loan extension. The dairymen weren’t vested in the budget and once it was put in the file, it was never looked at again.

Today, banks are requiring budgets and borrowing base reports monthly rather than quarterly, annually, or on an as-needed basis. There has also been an increase in the level of CPA-prepared financial statements in order to provide the bank with more assurance that the financials accurately reflect the records of the dairy.

The new requirements pushed on dairymen are abnormal business practices for dairies but standard for all other industries. Dairy operators need to implement these tools into permanent practice. They are invaluable.

We know as CPAs we cannot tell you how to milk cows and operate your dairy. That is your expertise, not ours. However, we do work with many different dairymen and prepare a significant amount of financial statements. From that, we can help you see where your financial statement and operations may be different from the average (whether above or below).

This is a critical tool in order for a dairyman to plug the holes in the ship. Doing this on a quarterly or monthly basis allows you to actively check and find the right balance for your operation.

Business today is a different ballgame, and it doesn’t appear it will ever change back to the previous way of business. It is going to take a progressive change to the mindset of most dairymen in order to adapt and accept higher financial standards. Ask the hard questions of your financial team. You should see your accountant, banker and attorney as your advisory board, not your adversary.

By doing this, you will create a business environment in which you can make timely, informed and strategic business choices.

Based in Idaho, Mark Brady is a partner with the firm of Cooper Norman Certified Public Accountants. Brady is a Certified Public Accountant (CPA) and a Certified Valuation Analyst (CVA). He grew up on a Montana dairy. Contact him at 208-733-6581 or mbrady@coopernorman.com.

Whether it involves a heifer grower or a corn silage supplier, assessing and managing your risk with the party on the other end of a contract gives you a better chance of minimizing potential problems.

By Greg Steele, AgStar Financial Services

Dairy farming is a risky business. It always has been and quite likely always will be. Risk exposure levels are becoming larger, land values are increasing and the scope of financing is greater. As dairy producers, you work to manage production risks on a daily basis. Now you have one more risk to keep track of—counterparty risk.

Here is a list of common questions that can be useful to manage counterparty risk.

What is it?

Simply put, counterparty risk is the risk that the party on the other end of your contract will not perform as was agreed upon, which results in a default on that contract. This can be broken down further into risk of:

• - payment default or delivery default;

• - the contract will have no value;

• - deferred payments will not get paid.

A recent example of counterparty risk was that MF Global, the world’s leading commodity trading company, filed bankruptcy because of its trades in European debt instruments. This event caused immediate liquidation of farmers’ futures and options positions, which lead to significant turmoil in the U.S. commodity markets.

How does counterparty risk happen?

There are two main reasons for contract default (other than fraud):

The other party is unable to meet the terms of the agreement (either financially or otherwise).

The other party’s perception or understanding of the agreement terms differs greatly from your perception.

You contract with a farmer to raise your replacement heifers and suddenly that farmer is short on cash and sells your animals to pay his expenses.

You contract for corn silage from a local farmer who fails to harvest the crops at the appropriate time or isn’t able to harvest the crops at all.

How do I assess my counterparty risk?

It is important to understand this process. What are the chances that I will suffer a loss? If one occurs, how I can manage the loss? A recommendation of how to determine what your risk is would include:

Identify the five to 10 largest third-party relationships you have, as these are your key business partners.

Put together a plan to review these partners and do your due diligence.

What kind of due diligence should I complete?

As a producer, you may feel like the shoes have switched feet and you’re now playing an unsecured creditor to most of your suppliers. This is especially true as the need to prepay for the largest discounts is becoming the standard and contract dates are moving further from the actual delivery date. Price volatility, length of time between contract date and shipment or time between payment and delivery are all factors that can increase the risk to you.

Always have written documentation of the transaction. Signed contracts are a common business tool.

Calculate the true cost of carry. Consider the interest cost on the early purchase.

Look for ways to narrow the time between performance and payment or possibly eliminate deferred income all together. Are you better off to take the income now versus the risk of recognizing zero if something happens to the other party in the future?

Deal directly with the source when possible. If there is a party in the middle, there is the additional risk of default.

Consider diversification. Don’t have all your eggs in one basket. Consider spreading your purchases and sales out over different purchasers or suppliers.

Identify other parties who might impact the outcome of the agreement. These might include business partners, parent companies, suppliers, banks or even landlords. Consider these parties’ interests when you review the agreement.

Look for additional tools to manage risk. Take immediate delivery, obtain a lien or find a way to guarantee payments.

Reducing counterparty risk is different for every dairy operation and not every example of counterparty risk has been identified. While intended to help you understand and navigate counterparty risk, these comments should not be taken as legal advice. Rather, they are provided as a framework to help you start planning for, assessing and managing your way through the uncertainties of the marketplace. As with any risk, the more you assess and manage it, the better chance you have of reducing it.

Greg Steele is vice president of agribusiness capital with AgStar Financial Services, ACA. His focus is working with commercial dairy operations that have grown and expanded their business. He provides expertise in the area of finance, business planning, and accounting. Contact Steele at (612) 963-7941 or greg.steele@agstar.com.